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Why I’d drop Fevertree Drinks plc like a hot potato

Image: Fevertree: fair use

There are very few stocks where, if you gave me some for free, I’d be rushing for the sell button as fast as I could. But current growth darling Fevertree Drinks (LSE: FEVR), is one of them. 

Don’t get me wrong, I have nothing against the company, which does seem to be performing nicely. My problem is what I see as the serious overvaluation that shareholders have pushed the shares up to in their enthusiasm to grab a piece of the action.

Sky-high valuation

It’s something I’ve seen many times in my decades of private investing. Some dynamic new prospect comes along and everyone wants a piece. So buyers pile in, and they push the share price to overheated levels.

In this case, at 2,311p, Fevertree Drinks shares are trading on a forward P/E of 82. And it’s not a company that’s cured death, or mastered cold fusion or anything like that — it just sells fizzy drink mixers.

To put it into perspective, earnings per share would have to multiply nearly sixfold to get the P/E down to average long-term FTSE 100 levels. And that’s going to take some time when EPS is forecast to grow at just 16% this year, dropping to 12% next year — we’re looking at maybe 10-15 years of future growth already built in to the share price.

A familiar tale

I remember something very similar happening to ASOS (LSE: ASC). That firm is in the relatively mundane business of selling clothes, but it does it very well and has seriously shaken up the world of online fashion retail — and its international expansion has been impressive.

ASOS shares did deserve a premium rating, for sure, but the market threw rationality out of the window and chased them to mind-boggling overvaluation. In early 2014, the shares topped out at more than £70 apiece, on an eye-watering P/E of greater than 150.

Then the inevitable happened. The growth story was derailed a little by inconveniences like global economics and the practical difficulties of maintaining supply channels while undergoing rapid international expansion.

Once bitten…?

ASOS shares crashed to around £20, and three years on they still haven’t regained that 2014 high. The price, however, has started soaring and at £59 today we’re looking at P/E multiples in excess of 70 again. 

I reckon a fresh slump for ASOS shares is extremely likely, and I can see exactly the same thing happening to Fevertree too.

Fevertree is a leader in its market, and its products are clearly of good quality and are in big demand. And it’s a very profitable business — the company is able to boast gross margins in excess of 50%.

And at the halfway stage, chief executive Tim Warrillow did suggest the full year would be “materially ahead” of previous expectations. But that valuation makes my toes curl.

When will it turn?

The shares might continue to rise, but there’ll be news at some point that does not fit the assumptions built into the price. And every time I’ve ever seen that happen to a popular growth share in the past, the share price has crumbled.

I do actually think Fevertree and ASOS are good companies with rosy futures, and I’d probably see them as good long-term buys at more sensible valuations.

But if I owned either of them today, I’d sell.

A better growth share

Where would I put the cash I got from selling any Fevertree shares you might give me? I reckon I could do a lot worse than this great growth candidate.

The Motley Fool report, A Top Growth Share, looks at a hot FTSE 250 company that has already delivered handsome rewards to shareholders. And with sales expected to top the £1bn mark in the near future, there should be plenty more to come.

Click here for your copy of this exclusive report.  It's 100% free and will be sent immediately to your inbox.

Alan Oscroft has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended ASOS. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.